Assignment 8

A SOLUTION TO THE CASE STUDY

Canada Pension Plan

BY

GROUP 11

Kshitij Saxena Shreyan Tharad Othman Kebdani

M155-17 M114-17 STEPPG03-18
8527603693 9831559471 6205804552
kshitij.saxena17@iimranchi.ac.in Shreyan.tharad17@iimranchi.ac.in othman.kebdani@iimranchi.ac.in
Group 11 IIM Ranchi 2017-19

a) Does CPPIB have a clear investment strategy? How would you characterize it? How

similar or different is it from Yale’s?

 Yes, CPPIB has a clear investment strategy. It used the “Total Portfolio Approach”

to optimize its portfolio’s risk and returns. It initially followed a passive investment

strategy till 2005, after which it started following a value-added approach. Its

reference portfolio was a mix of 65% equity (10% Canadian and 55% foreign) and

35% debt (30% Canadian nominal debt and 5% hedged foreign sovereign bonds).

 Active investing was adopted to improve on the reference portfolio through

“better beta” and “enhanced alpha”. CPPIB avoided external intermediaries by

developing in-house expertise, and did not invest through fund of funds. An active

investment was made only if it improved on the risk/return profile, and passive

holdings could be sold to fund the investment. This was termed as a “straight

substitution”.

b) To what extent is CPPIB saving money by investing directly? If it were instead to

invest in traditional private partnerships through funds-of-funds, how much better

would the private equity partnerships need to be to justify their fees? Compare CPPIB’s

approach with the alternative of investing through a fund-of-funds. In analyzing this

question, you may wish to assume that:

1) CPPIB invests $1 billion over three years into direct deals:

i) These funds are invested 1/3rd. each year.

ii) It pays no fees or carried interest on these transactions.

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Group 11 IIM Ranchi 2017-19

iii) The cost of compensation and fees associated with the investment is

approximately 1.5% of the amount invested, incurred at the time of the deals.

2) It could alternatively invest this capital in funds-of-funds:

i) The funds are typically drawn down in three equal tranches, 1/3rd. at the time

of the original investment, 1/3rd. one year later and 1/3rd. two years later.

ii) The private equity funds typically charge a management fee of 1.5% and a

carried interest of 20% of capital gains.

iii) The funds-of- funds typically charge a management fee of 1% and a carried

interest of 5% of capital gains.

3) Assume the return on these investments is 2.5 times (before fees) in five years.

15% is a reasonable discount rate for low beta levered companies.

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Group 11 IIM Ranchi 2017-19

Investment(Total) 10000,00,000.00
Annual 3333,33,333.33
Fees
Year 1 3333,33,333.33 50,00,000.000
Year 2 6666,66,666.67 100,00,000.000
Year 3 10000,00,000.00 150,00,000.000
Total 10000,00,000.00 300,00,000.000

Annual Return 20.11%

Private Equity
Management Fees Performance Fees
Year 1 3333,33,333.33 50,00,000.000 134,08,295.60
Year 2 6666,66,666.67 100,00,000.000 268,16,591.20
Year 3 6666,66,666.67 100,00,000.000 268,16,591.20
Year 4 10000,00,000.00 150,00,000.000 402,24,886.80
Total 10000,00,000.00 400,00,000.000 1072,66,364.790

Fund of Funds
Management Fees Performance Fees
Year 1 3333,33,333.33 33,33,333.333 33,52,073.90
Year 2 6666,66,666.67 66,66,666.667 67,04,147.80
Year 3 6666,66,666.67 66,66,666.667 67,04,147.80
Year 4 10000,00,000.00 100,00,000.000 100,56,221.70
Total 10000,00,000.00 266,66,666.667 268,16,591.198

c) If you were another LP in a fund with CPPIB and you see CPPIB co-investing

alongside the General Partner (GP), how would you react?

Co-investment and co-sponsorship is bound to create tensions between partners. CPPIB is a fund

with tremendous financial clout. In case the LP has the clout of CPPIB, they can choose to either

partner with or outbid CPPIB. If not, the LP should focus on its investment, and be clear of the

financing and holding structure of the partnership.

d) What risks and challenges do CPPIB’s strategy pose? How might it backfire? People are

an essential part of private investing. How does CPPIB recruit and retain its investment

staff? What challenges does it face?

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CPPIB was very aggressive in setting higher targets for itself. This resulted in it becoming the

largest pension fund in Canada. The challenge lay in how to remain relevant as the overall

fund got larger. As deal sizes got larger, it became harder for CPPIB to find opportunities that

matched its requirements. If this continued, the Private Investments group’s share in the fund

would reduce.

CPPIB managed to attract talent due to its business model and culture. They were not a top

player, but paid fair market compensation with a carry. The compensation consisted of a basic

salary, STIP and LTIP. There were a number of other initiatives, like creating the post of a VP,

that allowed CPPIB to retain talent.

The challenge CPPIB faced was to provide the right kind of career development and

opportunities for its employees whilst becoming a more mature organization.

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